(Common equity-dividend-growth model) A company\'s common stock is currently sel

Question

(Common equity-dividend-growth model) A company's common stock is currently selling for $24.00 per share. The company recently paid an annual dividend of $1.60 per share, and investor, forecast that the dividend will grow to $3.30 in 10 years. An investment bank has advised that a new issue could be sold for a flotation cost of 7% of face value. Calculate the annual dividend growth rate forecast for the company. Calculate the dividend anticipated in one year. Calculate investors' required rate of return from the company's common stock. Calculate the company's cost of retained earnings and cost of a new stock issue.

Explanation / Answer

(D) Cost of retained earnings when there is flotation cost :


i) Cost of retained earnings(Kr) = ( Cost of equity(ke) x 1--Fc) --------------- a*b) == (.6223*(1--0.07) == .578739 (i.e., 57.8739%)


working notes :


ii) Flotation Cost (Fc) = 7% per face value (0.07 per share) ------(a)

iii) Cost of equity(Ke) = ( Expected dividend / current market selling price of share ) + Growth

= (3.30/24.00) + .4848
= 0.6223 ----------- (b)

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